Dependency or contagion between the Islamic and conventional banking system: evidence from the FIEGARCH-EVT-copula model

Abstract

The objective of this paper is, firstly, to test the existence of contagion between the conventional and Islamic banking system, and secondly, to determine the best hedging strategy for. We use a FIEGARCH-EVT-copula model to analyse the dependence structure between the two banking systems in Gulf Cooperation Council (GCC) countries during the period from 16 June, 2006 to 15 May, 2013. Our results show the existence of a significant dependence between conventional and Islamic banks especially during the crisis period. The increase of the Kendall tau between the period before the crisis and the crisis period shows that financial contagion can be one of the most important factors of financial distress of Islamic banks. Concerning the best hedging strategy for conventional-Islamic stock portfolio, our results underscore the Islamic banking index usefulness in terms of reducing portfolio risk. Our results also corroborate the effectiveness of the hedging futures of Islamic banking indices.